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| Fiduciary Focus: Keep Your Eye on the Octopus |
| by
W. Scott Simon
| 09-07-06 |
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Last spring, I attended a financial services conference where the discussion turned to the Uniform Prudent Investor Act. My ears perked up at that point, because I have more than a passing interest, having written The Prudent Investor Act: A Guide to Understanding.
Someone in the audience piped up and said that it was his understanding the act was being displaced by the Uniform Trust Code. How do such vicious rumors get started? So one reason for this month's column will be to set the record straight and lay to rest this unfair assault on the good name of the Uniform Prudent Investor Act.
Another reason for this month's column, which will be a respite from my (so far) four-part series on non-fiduciary investment consultants, is to spread the good word about publication in July of the Uniform Prudent Management of Institutional Funds Act. That act, among other things, governs the investment conduct of trustees responsible for non-profit money such as foundations and endowments.
The Bible: Restatement 3rd of Trusts (Prudent Investor Rule)
Think of the Restatement 3rd of Trusts (Prudent Investor Rule)--always a mouthful--as the bible of trust investment law in America. The Restatement is the scholarly and authoritative forebear of the Uniform Prudent Investor Act. In fact, the Restatement can be thought of as a kind of Godfather to the act.
Before getting into what that means, I'd like to answer a basic question that a number of people have asked me: Just what the heck is a restatement? A restatement is a legal treatise that examines the common law and state statutes in a particular field of law and restates them as broad legal principles. These principles (as formulated in a restatement of law) often become a source of authority that is given great respect by courts and legislatures.
There are restatements in many different fields of law, such as criminal law, tort law, remedies law, criminal law, and, of course, of great interest to all modern prudent fiduciaries, trust law. The organization that publishes restatements of the law is the American Law Institute, which was established in 1923. The purpose of the institute, an influential group of attorneys, law school professors, and judges, as stated in its charter is "to promote the clarification and simplification of the law and its better adaptation to social needs, to secure the better administration of justice, and to encourage and carry on scholarly and scientific legal work."
The first volume of the multivolume Restatement 3rd of Trusts, which covers the Prudent Investor Rule, was published in 1992. This was the result of a long effort by the distinguished committee of attorneys and law school professors charged with drafting a new Restatement of Trusts to update the 1959 Restatement 2nd of Trusts. (The first Restatement of Trusts was published in 1935.) Every committee with the responsibility of drafting a new restatement of law has a head honcho drafter, or what is known formally as a Reporter. The Reporter for the Restatement 3rd of Trusts is Edward C. Halbach Jr., the Walter Perry Johnson Professor of Law Emeritus at the University of California Law School.
One of the overarching goals of the committee drafting the Restatement was to revise and supersede the Prudent Man Rule. According to this rule, first set forth in the 1830 Massachusetts case of Harvard College v. Amory, the goal of a fiduciary is to make the assets it manages productive by seeking the highest income possible while safeguarding the value of the principal. The Prudent Man Rule gradually became prevalent in most U.S. jurisdictions through legislation and court opinions and was the rule in the Restatement 2nd of Trusts.
Dissatisfaction with the Prudent Man Rule began to appear in legal and investment circles as the tenets of Modern Portfolio Theory were applied in the 1960s. The Prefatory Note to the Uniform Prudent Investor Act explains: "From the late 1960s the investment practices of fiduciaries experienced significant change. The [Uniform Prudent Investor Act] undertakes to update trust investment law in recognition of the alterations that have occurred in investment practice. These changes have occurred under the influence of a large and broadly accepted body of empirical and theoretical knowledge about the behavior of capital markets, often described as 'modern portfolio theory.'"
The committee drafting the Restatement, therefore, sought to revise and supersede the Prudent Man Rule by incorporating modern theories of investment and finance into the general language of the Restatement's Prudent Investor Rule. This underscores the central importance of Modern Portfolio Theory in investing and its tremendous influence in prompting and shaping the reform of U.S. trust investment law. In fact, Modern Portfolio Theory provides the theoretical underpinnings of the Restatement as well as the Uniform Prudent Investor Act.
The black letter and comments of the Restatement represent the official views of the American Law Institute. The Reporter's Notes to the Restatement, which contain supporting authority, explanation, and other discussion by the Reporter, were not reviewed by the institute and thus are not considered part of its views. Given the prestige of the institute, its pronouncements in the different restatements of law carry great influence and are a ready source of authority for courts and legislatures to follow. Nonetheless, the institute is not a governmental body and no restatement of law has the sanction of any statute.
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| W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing. Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals. For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. |
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